Published on Wednesday 27th February 2019
Has the level of M&A activity slowed, increased or remained flat in 2018 as compared to 2017, and what are conditions like today? In general terms, what level of activity is foreseen for 2019? What are the factors influencing the level of M&A activity – Economic? Political? Commodity prices? Weakness in currency? Stock market performance? Liquidity? Rule of law? Other?
According to the Economic Commission on Latin America, the Republic of Panama has the highest FDI-to-GDP ratio in Latin America and is positioned to continue receiving significant investment inflows in the near term. Not surprisingly, M&A activity in Panama has remained stable over the last few years across an ample spectrum of industries, with important acquisitions occurring in 2014 and 2015 in the energy and financial services sectors. Recent notable transactions include, in the financial services sector, Citibank’s sale of its retail banking business to Scotiabank and in the energy sector, Celsia SA, ESP’s purchase of Suez Energy Central America’s assets, including Suez’s 51 per cent share of Bahia Las Minas, Panama’s largest coal-fired thermal power plant, Interenergy’s purchase of UEP II, the project company developing the second and third phases of the first wind generation farm in Panama, and Interenergy’s indirect acquisition of Conduit Capital Partners 55 per cent interest in Pedregal Power, a 55MW diesel power plant in Panama.
In general terms, we expect M&A activity to continue in these and other sectors of the economy, as Panama’s ongoing GDP growth (in contrast with economic turmoil in other economies of the region) continue to attract FDI into the country. It is worth noting that the completion of the Panama Canal expansion project will likely be the primary driver of M&A activity in the coming years. The Panama Canal, already a backbone of the Panamanian economy contributing approximately US$1.1 billion to the national revenue, is expected to jump to US$4 billion per year in the long term following the expansion project. This will have predictable spill-over effects into ancillary and complimentary industries such as export processing, transportation and maritime-related services, resulting in further opportunities for outright acquisitions and joint-venture investments. Indeed, anticipating this area of growth, the Panama Canal Authority (ACP) is preparing to launch a public tender for the construction and operation of a new transhipment container terminal to be located near the Pacific-entrance to the Panama Canal and capable of accommodating Post-Panamax ships with docking facilities with an estimated depth of 60 feet, and the capacity to handle 5 million TEUs in a 296-acre area.
Which industries do you expect will see the most M&A activity in 2019?
In the near-term, we expect M&A activity to continue to be distributed across several industries, lead most likely by the traditional financial services (including insurance) and energy sectors, followed by logistics, transportation and distribution.
In the energy sector specifically, following the Panamanian economy’s long period of double and high-single digit growth , energy demand in the country is expected to continue to increase at an annual rate of 4.8 per cent to 7.5 per cent, requiring, by some estimates, approximately 120MW of additional capacity per year to keep up with demand over the next 13 years. We therefore expect to see stable, if not increasing, activity in the area of through joint-venture investments.
As noted above, we also expect greater M&A activity in the logistics and maritime services industries. This sector is primed to grow following the completion of the Panama Canal expansion and as the current administration’s plans to position it as a cornerstone of its economic growth policy. To that end, the government of President Juan Carlos Varela has pledged US$3.2 billion during his presidential term in infrastructure and related investments in the logistics and transportation sectors (including various civil works for infrastructure redevelopment).
We also expect M&A activity to pick up in the retail trade and hospitality sectors to be target of M&A activity, as the former continues to experience growth and the latter is perceived ripe for consolidation given an oversupply in hotel room occupancy.
What types of deals do you expect to see?
We expect to see a higher level of outright acquisitions, followed by mergers, minority investments and a few joint ventures. Outright acquisitions have historically been the leading type of M&A deal, and we expect that trend to continue, specifically in the financial and energy sectors. However, in 2016 we expect to see an increase in joint-ventures in the food, retail and hospitality industries, driven both by internal market-size limitations and the need for local partners, as well as opportunities for consolidation led by a saturated hospitality (hotel) industry.
Discuss the level of M&A activity you have seen over 2018 and expect to see in 2019 of:
(i) pure domestic deals;
(ii) deals in your jurisdiction involving a domestic target and foreign acquirer from Latin America, or a foreign acquirer from outside Latin America; and
(iii) deals involving a domestic acquirer and foreign target in Latin America or a foreign target outside Latin America.
The majority of M&A transactions in recent years have been in deals involving a domestic target and a foreign acquirer from Latin America, Europe or the United States. It is certainly the case that Panama’s GDP growth (6.1 per cent for 2015) will continue to make local companies more attractive targets for acquisitions. But given the high-level of acquisitions of domestic targets by foreigners in the last five years, and the limited opportunity for internal growth due to Panama’s market size limitations, there might be some decline in the number of outright foreign-led acquisitions across some sectors.
While we expect this trend to continue and that most of the M&A transactions taking place in 2016 will likely involve a domestic target and a foreign acquirer from Europe, the United States or Asia, purely domestic deals activity across industries should not be understated, as local companies seek to consolidate to better compete amidst increased competition from new market entrants (usually large multinationals), or look to merge in order to position themselves as a viable targets for further acquisitions. Less frequent are deals involving a domestic acquirer and a foreign target in Latin America or outside of Latin America.
What is the level of private equity activity? Are domestic or international funds involved? What kinds of deals are they doing?
The level of private equity activity in Panama is increasing, although still a small percentage of total M&A activity in Panama given the size of the market. In recent years international private equity funds have been investing in Panama in certain specific industries, principally in the energy, mining, and hospitality and services industries. Although private equity interest in Panama remains high, many deals in other sectors fail to perfect given the potential returns vis-à-vis the relative small market size.
Is acquisition financing available for deals? Where is financing coming from? How much concern do you have that an increase in interest rates or risk of a recession will limit the availability of financing?
Acquisition financing is available for deals in Panama, and domestic financing for deals, particularly for asset-backed purchases, are on the rise. In 2010 Moody’s (Baa), Standard & Poor´s (BBB-) and Fitch Ratings (BBB-) assigned Panama an investment grade rating, which has since upgraded by Moody’s (Baa2), Standard & Poor's (BBB) and Fitch Ratings (BBB). Coupled with its internationally recognised banking centre, a robust and well-regulated securities market, and the use of the dollar as legal tender that eliminates currency exchange risk for investors in developed countries, Panama is an important hub for financial services, including acquisition financing. However, given that most M&A activity involves foreign investors looking to acquire a domestic target, it is often the case that such foreign investors have secured their acquisition financing abroad, although we are seeing an increased willingness and participation of domestic banks in financing of M&A deals.
How open is your country to investments and acquisitions by foreign buyers? Is there a level playing field when foreign and domestic bidders compete to buy the same domestic target company?
Generally, there are no restrictions to foreign ownership in Panama. In addition, Panama does not have a central bank, nor does it have any currency controls or restrictions on the free flow of capital into and out of the country. As a result, foreign-direct investment continues to be a principal driver of M&A activity, with most of the larger mergers and acquisitions in the past decade have been by foreign buyers in a wide range of local industries.
Due to issues of national security and national interest concerns, however, ownership of local companies by foreign governments or nationals is restricted in certain industries including aviation, radio and TV, and retail trade, with some exceptions. In fact, nonetheless, there is generally a level playing field when foreign and domestic bidders compete to buy the same domestic target company.
Are corruption and compliance concerns affecting M&A activity? Are there industries where this is a particular issue?
At a macro level, studies conducted by non-governmental organisations have generally concluded that government corruption, and negative perceptions of such corruption, have an impact on overall levels of FDI in a country. Although difficult to measure, Panama is no exception to this genera rule. Despite its unprecedented decade of growth, recent government corruption scandals in the past administration have likely impacted the overall level of FDI in Panama, and consequently, M&A activity, specifically corruption concerns, have manifested themselves in M&A deals through greater scrutiny by foreign buyers at the due diligence stage in regards to sellers’ disclosure on reporting requirements, violations or compliance with regulatory permits and licences, and adherence to anti-corruption regulations. In heavily regulated industries, foreign buyers are also increasingly requiring that sellers divulge (and that their local attorneys inquire about) the process by which permits and licences were initially obtained by the target company. During the contract negotiation stage, foreign buyers are insisting on including more FCPA-and related statute specific reps, even when such compliance concerns are not shared by local sellers and specific corruption-related reps are not typically found in local law agreements.
Moreover, owing to recent corruption scandals, certain regulatory authorities in the energy, telecommunication, securities, and banking sector have taken extra precautionary actions that have impacted M&A transactions in regulated sectors.
How big a part of M&A activity is the restructuring of financially troubled companies? Have you seen more of this in 2018 as compared with 2017? What are the prospects for 2019?
The restructuring of financially troubled companies has not been a large part of M&A activity in Panama in recent years. Generally speaking, we have not seen any increase in 2015 as compared to 2014, and do not anticipate any particular increase in 2016, with noticeable exceptions in the wholesale export and distribution sector and specifically companies that have significant exposure to the deteriorating economic conditions in Venezuela and other Latin American countries.
Does your country’s bankruptcy law permit the reorganisation of the debtor as a going concern, and the acquisition of the entity out of bankruptcy? Are you seeing much activity in this area?
As opposed to countries such as the United States that allow companies to reorganise as a going concern (Chapter 11 provisions), Panama does not have a similar bankruptcy regulation. In some regulated activities (banking, insurance, securities), specific regulation does allow for regulatory intervention that could result in some form of reorganisation of the particular entity as a going concern, but these cases are the exception and not the rule. In practice, the probability of an acquisition of a Panamanian entity out of bankruptcy is not likely. That said, legislation was presented for approval of the National Assembly in January 2016 to allow for reorganisation of a financially troubled company as a going concern, with the aim of further protecting good faith debtors, and further consolidating and regulating the disparate, outdated and limited bankruptcy statutes dispersed throughout our civil and commercial codes. But as of the date of this article such legislation was still under debate and yet to be enacted.
Has there been any increase in public company M&A?
How well protected are minority shareholders in public companies? What recent developments have there been as relates to independent directors, special committees, independent advisers, fairness opinions?
Panama has few statutory protections for minority shareholders. Some regulated industrings (such as the financial services sector), require independent directors and the implementation of special committees, such as audit committees, however, there have not been significant new development in these areas. In practice, and where possible, minority investors should seek protection of their rights, in both public and private companies, through carefully negotiated shareholders' agreement.
Has there been any increase in shareholder activism and hostile takeovers? Are international hedge funds active in your market? What defences are target companies permitted to adopt?
We have not perceived an increase in hostile takeovers or shareholder activism in Panama.
Have directors, management and controlling shareholders changed how they conduct themselves in M&A deals? What kind of fiduciary duties do directors, management and controlling shareholders have under the laws of your jurisdiction? From your experience, are directors, management and controlling shareholders more diligent today in their review of M&A transactions and other matters?
Yes, in general terms, the board of directors and top management of operational Panamanian companies, and especially those in regulated industries, have become significantly more professional and sophisticated, and are therefore more likely to be concerned about issues like negative publicity, shareholder criticism, regulatory pressure and liability from potential litigation, whether or not in the context of an M&A transaction.
It is also worth mentioning that the influx of foreign and strategic buyers to Panama has brought with it a wealth of managerial expatriate talent over the last decade. Consequently, over this same period Panama has also seen a modest rise in the number of international directors serving on local corporate boards, adding a wealth and diversity of experience and backgrounds to the companies they oversee. The unprecedented level of growth experienced by Panama in the last decade has coincided with a rise in the number and sophistication of “family offices.” These “family” offices increasingly rely on a professional cadre of managers and independent directors to oversee the diverse and significant investments of these family-owned investment vehicles.
Should directors, management and controlling shareholders be more concerned today about negative publicity, shareholder criticism, regulatory pressure, shareholder lawsuits and liability from potential litigation?
Yes. Following an era of unprecedented government corruption, Panama, under the new administration of Juan Carlos Varela, is attempting to erase public perceptions of entrenched corruption, and brining to justice those accountable for mismanaging public finances. Consequently, Panama is also experiencing an unprecedented period of regulatory scrutiny across all industries, coupled with a new sense of purpose and urgency by civil society and watchdog groups. In that context, management and controlling shareholders are, and should be, more concerned today about negative publicity, and particularly, due compliance with regulatory and licensing issues, and transparency in both private and public transactions.
Are there major differences in how domestic and cross-border deals are being conducted? For instance, does the type of purchase agreement used in your jurisdiction differ significantly from the international style of agreement? If so, which type is being used more often?
There are still notable differences in how domestic and cross-border deals are conducted. The type of purchase agreement used in Panama depends a great deal on the nature of the transaction. If the transaction involves a domestic acquirer and a domestic target, it is very likely that the purchase agreement will be a far simpler document than a purchase agreement used when the acquirer is a foreign investor. The differences are mostly reflected in the amount and scope of the representations and warranties, and the affirmative and negative covenants, which tend to be more comprehensive in international-style purchase agreements.
The size of the transaction will also have a bearing on the type of purchase agreement that is finally used. As a general rule, foreign investors tend to feel more comfortable using international-style purchase agreements, most often governed by New York law and using both New York counsel and Panamanian counsel in its drafting and negotiation. Cross-border deals driven by foreign strategic investors usually have longer survival periods for indmenities, and a more prevalent use of escrow agreements. Given that there are a larger number of transactions involving foreign acquirers, the international style of purchase agreement is being used more often.
Have there been changes in the process for how M&A transactions are conducted in your jurisdiction?
No specific changes have taken place in Panama in regard to how M&A transactions are conducted. Business combinations in Panama are typically structured as share or asset purchases, tender offers or mergers, but other structures can also be used. One example is the capitalisation of shares of two operating companies to a holding company incorporated for that purpose with joint participation in the holding company. In the case of publicly traded companies, combinations usually involve a two-step process that begins with a tender offer (either for shares, cash or a combination of both) followed by an actual merger.
How level is the playing field for domestic and international bidders?
Yes, domestic buyers usually have a greater tolerance than multinational buyers for risk surrounding tax and labour matters in M&A transactions, given their familiarity with the issues and their practical impact on a target’s operations. This does not necessarily give domestic buyers any particular advantage over international buyers, as the determining factor is typically price and certainty of closing. Because FCPA and other international anti-corruption statutes are becoming the norm in most purchase agreements for M&A transactions and, in our view, do not present a significant challenge for international buyers in Panama. That said, foreign buyers are advised to build-in additional time and efforts in managing the due diligence process with domestic sellers, in order to ensure a smoother process surrounding FCPA and similar disclosures, particularly when dealing with the purchase of family-owned companies.
For international buyers and investors looking at deals in your jurisdiction, what are the three most important pieces of advice you have and what are the three most important pitfalls that should be avoided?
As must be the case for most jurisdictions, the three key things that potential buyers and investors in Panama should do are:
Have there been any significant regulatory developments affecting M&A – your country's securities exchange commission, antitrust regulators, tax authorities, Central Bank, other regulators that review deals etc?
Share purchases are subject to a 10 per cent capital gains tax on Panama source gains in the same manner that share for cash mergers are taxed, including the 5 per cent advance withholding obligation. The Department of Revenue of the Ministry of Economy and Finance has repeatedly taken the position that capital gains tax applies to the sale of the shares not only of Panamanian corporations, but also of any upstream company, regardless of its jurisdiction of incorporation, as long as this company, directly or through one or more subsidiaries, has Panama-source income. Consequently, gains derived from the direct or indirect transfer of shares of a legal entity that has obtained Panama source income is subject to a tax a rate of 10 per cent.
Until recently there were no income-allocation or distribution rules to attribute Panama-source vs non-Panama source income to the total purchase price in a share purchase deal. As such, in cross-border share purchases or mergers, transactions were often structured so that the sale of Panama-based assets or operations are segregated and sold separately from the operations in other jurisdictions. However, due to a recent tax reform (Decree Law 135 of 2012), where a transaction involves, indirectly, the transfer of shares of a Panamanian company with Panama source income, the seller and buyer can now apply pre-established calculations to determine the capital gains tax due on the percentage of the purchase price of the transaction that is deemed to constitute Panama source income. To pay the capital gains tax, the buyer and seller will need to file a joint sworn affidavit setting forth the total capital gains tax paid and the calculations used to arrive at the figure. In addition, the buyer, who is responsible for the payment, must obtain a temporary tax identification number in Panama, known as 8-NT, to report and pay the capital gains tax. This temporary registration has no additional tax implications or reporting requirements in Panama for the buyer.
Although not specifically regulated in any law, decree or administrative order, the Ministry of Economy and Finance, has recently implemented a practice whereby the parties are also required to submit a Spanish language translation of the purchase agreement together along with the capital gains tax payment, raising some confidentiality concerns and an increase in time and transaction costs in what otherwise tend to be confidential, private transactions between parties.